Expert Witness Advice on Prosecuting & Defending Bank Director & Officer Liability Lawsuits Filed by the FDIC
The author, a veteran expert witness for the government and defendants in extensive FDIC D&O litigation in the previous banking crisis, explains some of the important issues in director and officer liability litigation, and how to handle them.
N.B. This article was originally published on June 24, 2010, predicting the imminent commencement of the filing of D&O lawsuits by the FDIC. The FDIC filed its first D&O lawsuit of the current banking crisis eight days later on July 2, 2010.
Having been through the previous banking meltdown first as a high-level banking executive, then as a high-level banking regulator, and later on as a busy banking expert witness, and in Texas, no less, I knew that it was only a matter of time before I began to hear rumblings of the beginning of the FDIC’s efforts to initiate litigation against the executive officers and directors of some of the almost 250 banks that have failed since January 2008. And if the doomsayers are correct – and they very well may just be correct – we may see another 200 to 300 banks fail before all is said and done.
Recently, I have seen and heard more and more indications that the FDIC is nearing the point where they will begin filing director and officer lawsuits. Consider the following:
● Reportedly, the FDIC recently added additional staff attorneys to its professional liability function.
● Likewise, I have heard that the FDIC has even reenlisted some of its retired professionals and litigation veterans from the previous banking crisis in its ramp-up effort leading up to the wholesale filing of directors and officers liability litigation.
● I have had other confidential contacts that lead me to believe that this litigation process is moving forward.
The FDIC’s Litigation Process
It appears to me that the FDIC is taking a slow and methodical right-foot, left-foot approach in order to make sure that they have all of the information they need to ensure that they pursue cases where they have the greatest chance of bringing home the bacon.
So far, it appears that the process that is being followed by the FDIC this time around is a multi-step process that goes loosely along these lines:
1. The FDIC examines the records of the failed bank.
2. They interview some of the failed bank’s key personnel.
3. At some point, and depending upon the findings in 1 and 2, a more detailed investigation is conducted.
4. A written summary report called a Material Loss Review is generated, published, and made available to the public. The FDIC may contract with an accounting firm to perform the Material Loss Review.
5. Again depending on what is found in the FDIC’s investigation, they may discuss their findings with outside counsel, and direct them to further investigate with the possibility of legal action being filed eventually, depending on what the attorneys learn during this discovery phase.
6. If it is determined that there is cause to pursue litigation, the FDIC issues a demand letter to whomever it has tentatively determined to be culpable.
7. If the FDIC determines that litigation is warranted, normally it is their practice to notify the parties that will be sued in order to provide an opportunity to settle without litigation.
8. Failing settlement, the FDIC, through its outside counsel, files a lawsuit.
Of course, there may be some variations in this process; but the basic overall process seems to be as cited here.
Categories of Problems at Failed Banks
Problems that cause concern for the FDIC fall into two general categories, personal and corporate, recognizing that there is some overlap:
On the personal level, directors and officers may be personally liable for financial harm caused to their bank if they:
• Misappropriate a bank asset for personal benefit.
• Misappropriate a bank opportunity for personal benefit.
• Breach their duty of loyalty to the bank.
• Commingle personal assets with bank assets.
• Fail to disclose obvious or potential conflicts of interest.
On the corporate level, directors and officers may be personally liable for financial harm caused to their bank if they appear to have committed infractions that fall under the headings of good faith, ordinary care, honesty in fact, fair dealing, and reasonable commercial standards that upset the FDIC enough to encourage them to pursue litigation, such as:
• Originating poor quality loans.
• Inadequately documenting loans.
• Improperly servicing loans.
• Originating inappropriate loan types given the economic environment.
• Originating inappropriate loan types given the bank’s size and capital.
• Failing to address asset and liability mismatches.
• Any other action or inaction that the FDIC sees as inappropriate.
How to Analyze and Address Perceived Problems
There are many ways to view and analyze the various problems that may be cited in FDIC litigation filed against directors and officers, such as:
● In my experience, the best way for both sides to address the problems contained in a complaint by the FDIC aimed at directors and officers is to document and present a paper trail of how and why each criticized decision was reached. If that is not possible due to a lack of documentation (see discovery comments in the next section), then a critical analysis by a respected banking professional should be presented. In this analysis, the particular situation under consideration should be analyzed in light of what was going on in the local economy at the time, and the bank’s rationale for its action.
● In addition, questioned actions can sometimes be criticized or supported by citing the presence or absence of similar actions at other banks.
● It is important to demonstrate whether or not the directors and officers of the bank operated the bank within nationwide industry standard practices and procedures for similarly situated banks.
● It should be determined whether or not the bank had in place adequate industry standard policies and procedures, and whether or not they were made known to the staff.
● It should be determined whether or not these policies and procedures were made available to the staff in a policy and procedure manual or another adequate form.
● It is important to note any training records that demonstrate that the staff was trained in the bank’s policies and procedures.
● Any “hot money,” such as brokered deposits, should be forensically traced to specific investment transactions where the investment outcome can be determined.
● Sale and servicing agreements with investors buying loans from the bank should be examined for any restrictions that may have been required in order to allow the origination of unusually structured loans.
● Loans that are criticized due to unusual structuring or underwriting yet were originated to comply with a sale to an investor who had effectively approved the structuring or underwriting in advance should be examined for their potential profitability and compliance with other loans originated in the marketplace at the time.
● Loans that were originated with a reduced level of or no verifications during the underwriting process (low-doc or no-doc loans) should be examined for compliance with Fannie Mae or Freddie Mac programs that were extant at the time that the loans were originated, and for compliance with a reasonable economic substance analysis.
● It should also be pointed out that the major problem that caused the nationwide real estate market to hit the wall was the simple fact that real estate property values began to decline, even though the vast majority of the professionals in the country – including the Federal Reserve – thought that these values would continue to rise. Almost all lenders relied on this expected continued upward trend in real estate property values, but it did not materialize.
● Any economic damages that are claimed in the FDIC’s litigation should comply with accepted economic damages valuation methodology.
● Quite often, economic damages for specific assets are calculated based upon liquidation prices at the very bottom of the economic cycle; but for any asset where economic damages in the form of losses are claimed, an analysis should be completed demonstrating that holding onto the asset for a reasonable period of time would produce a higher value and result in a lower loss or possibly no loss at all.
There are many other ways to analyze, answer, explain, or mitigate many other potential problem areas cited in director and officer litigation.
While keeping in mind that I am not an attorney, having served as a high-level banking regulator during the previous banking crisis, and as an expert witness numerous times after the crisis, I do know certain important facts based upon my firsthand experience. For example:
● When the FDIC takes over a failed bank, it basically inherits all of the documents in the bank, which greatly facilitates their discovery.
● One of the first actions of the FDIC after taking over a bank is typically to restrict (read, “cut off”) the access of officers, directors, and employees to all bank records.
● Likewise, after a bank failure, any legal counsel that the bank had before the failure immediately becomes the FDIC’s counsel (since the FDIC effectively steps into the shoes of the previous owners of the bank) and no longer represents the interests of the bank’s former officers and directors.
● Keep in mind that since the previous banking crisis, Al Gore invented the Internet (I’m just telling you what he said.); so the FDIC now steps into a goldmine of e-mail communications and other online assets when it takes over a failed bank.
● The FDIC almost always demands financial statements on directors and officers that are likely targets of their litigation.
● The FDIC searches public records, bank records, and any other records they can find in order to identify any asset transfers that might reduce the asset pool available to pay economic damages to the FDIC.
● The FDIC will not hesitate to search the personal computer records of directors and officers including their personal laptop and home computers.
FDIC litigation is serious business.
● If you are a director or officer of a bank that has failed or is close to failing, you should consider contacting your D&O carrier to discuss what to do next. They will tell you whether your insurance plan requires that you use certain lawyers specified by the insurance company or if you are free to choose other attorneys and submit them for approval by the insurance company.
● If you are an attorney defending directors and officers of a failed or failing bank, make sure that you are approved by the bank’s D&O insurance carrier, if that is required. Then seek out an experienced banking expert witness consultant that can help you navigate the various nuances of potential D&O liability discussed in this article.
● If you are an outside (outside the FDIC) attorney filing a directors and officers liability lawsuit on behalf of the FDIC, engage an experienced banking professional with extensive expert witness experience to assist you in identifying and analyzing the various issues that appear to have contributed to the failure of the bank.
(c) 2010 by Don Coker
ABOUT THE AUTHOR: Banking Expert Witness Don Coker
Expert witness and consulting services. Over 500 cases for plaintiffs & defendants nationwide, 120 testimonies, 12 courthouse settlements, all areas of banking and finance. Listed in the databases of expert witnesses recommended to both DRI and AAJ.
Clients have included numerous individuals, 80+ banks, and governmental clients such as the IRS, FDIC.
Employment experience includes Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, BofA, Regions Financial, and a 2-year term as a high-level governmental banking regulator.
B.A. degree from the University of Alabama. Postgraduate and executive education work at Alabama, the University of Houston, SMU, Spring Hill College, and the Harvard Business School.
Called on by clients in 31 countries for work involving 61 countries. Widely published, often called on by the media.
Copyright Don Coker
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.